Real lean thinker win in commoditized markets

Like death and taxes, commoditization of your products is a given. John Quelch offered a few tips in the Harvard Business Review Dec 14, 2007. But there is more to think about and act on: The focus of your lean activities needs to shift urgently!

If you heard a manager blaming „commoditization“ for failing to deliver sales or profits, it’s time to replace him/her with a lean thinking manager!

What is the connection between the article of John Quelch focusing on Marketing  and Lean Thinking?

Let’s have a look at John’s points first:
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Marketers can do three things to delay the inevitable forces of commoditization:

      • Innovate. A new product that better meets consumer needs, even an upgrade of an existing product, can one-up competitors and force them to invest in matching or exceeding the new specifications.
      • Bundle. Selling a commoditized product with differentiated ancillary services (such as after-sales service) can appeal to buyers willing to pay a premium for the convenience.
      • Segment. Mature markets are large markets that can be divided profitably into multiple segments. Marketers can focus on providing applications expertise for less price-sensitive customer segments for whom the product is still important.

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What does this mean in „lean words“?

The relevant of the two pillars in lean thinking is „Respect for People“. One of the principle, method and tool derived from „Respect of People“ is called „Voice of the Customer“. Inside most companies, „Voice of the Customer“ is not really the loudest voice. The volume of other voices is higher . The voice of the business is quite strong, shouting company internal KPIs at you. Measurements not offering any value to your customers like „internal/intercompany service level“ or „operator productivity“ are raised to be KPIs. The voice of power (one of the 4 real intrinsic motivations, besides challenges, job security and community spirit) is another adverse voice. E.g. check your Org-Chart! Where is Quality Management located? Under operations? Under the power of your COO? Then urgent counter action is required as in a commoditized market customer will define the word „Quality“ different than you do!

Put yourself in the shoes of your customer. Doesn’t matter what you produce you compete in 4 areas:
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  • DELIVERY. At the right time (=wish date, not confirmed date), at the right place (wish place, not loading ramp)!
  • QUALITY. Most probably here is the biggest gap between your self defined (product focused) understanding of Quality and the „Quality“ (Experience) of your customer!
  • PRICE (costs+ margin from productions site).Probably your company has a strong cost focus anyway. But do you offer the cost advantages to your customers?
  • INNOVATION. Innovation is not about continuous improvement (PDCA, Kaizens). It is about Kaikaku!

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Let’s translate John’s three things to delay the inevitable forces of commoditization in Lean:

  • [highlight bgcolor=“#801824″ textcolor=“#fbfffa“]John: „Innovate“ => Lean: „Kaikaku“[/highlight]
  • [highlight bgcolor=“#801824″ textcolor=“#fbfffa“]John: „Bundle“ => Lean: „Understanding quality based on voice of the customer and adding value“[/highlight]
  • [highlight bgcolor=“#801824″ textcolor=“#fbfffa“]John: „Segment“ => Lean: „Understanding that here is not „one“ voice of the customer but „many“ voices“[/highlight]

How to survive commoditization?

John Quelch recommends four actions:
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  • Decide which customers you do NOT want to serve, try renegotiating prices with them and, failing that, fire them. You will lose market share but improve profitability.
  • Compensate your salesforce on profit margin, not sales revenues. A volume-based salesforce will sign up any customer, regardless of profitability. That’s OK early in the product life cycle but not in maturity.
  • Trim costs and acquire competitors (with profitable customers) to extract maximum scale economies in procurement, manufacturing, and distribution.
  • If you aren’t the low cost producer, complicate your pricing structures so customers can’t easily make side-by-side comparisons, and provide discounts as needed of artificially inflated published prices.

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From the standpoint of a „marketer“ (or better sales man in this case), having no connection to production, this can be possible countermeasures to survive a bit longer. From my personal point of view and my experience I can just partly agree and I have to disagree stongly in some aspects!

I completely agree on recommendation 1: decide against non profitable customer  But first listen to them carefully, as they could give you the hint to differentiate from competition!

I agree on recommendation 2 if salesforce compensation is based on absolut figures and not on percentage!

I strongly disagree on recommendation 3 for a few reasons, based on lean experience within commodity industries. If you achieve to become cost leader because of higher purchasing power and some scale of economy effects than you will struggle with a lot of side effects of this strategy:
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    1. Post-Merger-Integration is not an easy topic for most companies. But to achieve the desired cost advantages you need to consolidate at least purchasing and reduce overhead.
    2. Scale of economies in manufacturing is mostely done in the wrong way. Increasing batch sizes because of an old understanding of standard costs will lead to high inventories (raw material, work in progress, semi-finished goods and finished goods) binding money, reducing cash flow and decreasing your profits.
    3. Scale on distribution will lead to high inventories on one hand and/or decrease of service level towards customer wish date on the other hand.

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Recommendation number 4 of John Quelch is absolutely not acceptable and even the worst recommendation I’ve ever seen from a „Marketing Expert“.  For more than 23 years I am client facing and learning constantly from our customers. In addition, I studied sales and marketing at various universities doing my MBA and further education. From my personal understanding on the topic of marketing and sales, I can’t hardly understand how someone can recommend to complicate pricing structure for customers. We are living in the age of the internet. Transparency is omnipresent. [notice]Companies trying hard to blur the clear view of customers on all details of your product will fail, sooner or laterl![/notice] Sooner or later customer will understand that their efforts to make your price comparable is a cost they have to assign to your product!

I really liked the beginning of John Quelch article and in the end I come to the conclusion that he missed the point as soon as he translated his hints to innovate, bundle and segment into actions of blind believe in scale of economies and mystify pricing pulling the wool over customer’s eyes.

Instead of John’s recommendation number 3 and 4, I would recommend the following:
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  • Redefine „Quality“ as the value add to the commoditized product (bundle and innovate)
  • Place Quality Management in the Org Chart on Execution Level
  • Start Kaikakus
  • Search for segments in other industries where your skills, knowledge and maybe some of your semi-finished goods are of interest (segment)
  • Understand bottlenecks in production and base product cost calculations on realistic values (see Theory of Constrains, The Goal)

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As the pressure is high in commoditized industries, it will be easy to find supporters within your company to initiate a dramatic change towards a profitable future.

Good luck!

Dietmar

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